In total, Equity Group has a presence in six countries while KCB Group now operates in seven countries. The two banks have disclosed plans to expand further beyond current coverage. They have also employed the subsidiarisation approach where subsidiaries are fully owned and maintain individual balance sheets.

While the expansion agenda not only elevates their regional profiles, it also invites systemic risks in their home markets.

Specifically, in Kenya – the home market for both banks – they both held a third of customer deposits and a quarter of total assets at the close of 2022. Apart from holding domestic credit and market risks, their balance sheets also carry additional cross-border risks, namely:

  • (i) sovereign-since they hold domestic debts in those cross-border subsidiaries;
  • (ii) political risks-since the cross-border subsidiaries operate in countries with varying political dynamics;
  • (iii) foreign currency risks-since they report in home currency.

Due to intra-group linkages, if a subsidiary in one part of its presence faces difficulty, the transmission into markets with systemic importance can be quite quick. For instance, if Equity’s operations in DRC runs into an existential threat (such as a run on deposits), the transmission into its other affiliates can be quite quick. The same applies to KCB Group.

‘Need to be declared D-SIBS’

They present significant systemic risks to domestic financial stability, largely due to their large balance sheets, regional presence and interconnectedness. Essentially, they are too big to fail. Consequently, these two banks need to be declared as domestically systemically important banks (D-SIBs) by the Central Bank of Kenya (CBK), the home regulator.

Such a declaration fits well with the risk-based regulatory approach where ‘the bank that takes more risk should have more capital’. By being declared as D-SIBs, they will be asked to put in place higher loss absorbency capabilities, by way of fortifying their balance sheets through higher capital adequacy and liquidity coverage ratios.

Additionally, they will be subject to robust stress-testing and more frequent on-site supervision. Specifically, the D-SIBs should be asked to set aside a much higher loss absorbency (HLA) by way of additional capital surcharge of a percentage to their respective minimum required capital adequacy levels, which should be met with shareholder funds through the Common Equity Tier 1 (CET1) capital.

Further, the following regulatory impositions should be put in place:

  • (i) higher liquidity coverage requirements that are subject to change from time to time;
  • (ii) quarterly stress testing on capital and liquidity;
  • (iii) they must develop specific annual recovery plan; and
  • (iv) make quarterly disclosures of their financial condition and risk management activities  as may be prescribed by CBK.

Consolidation under HoldCos

Another concern revolves around the fact that these banks consolidate their operations under non-operating holding companies (HoldCos). Due to lack of robust supervisory oversight of holding companies, disclosures on intra-group exposures, especially cross-border transactions, in itself pose a risk. This is probably exacerbated by the fact that cross-border resolution mechanisms aren’t robust enough.

Consequently, this calls for regular convention of supervisory college meetings for supervisors across the seven markets in which the two banking groups operates. In 2021, the Central Bank of Kenya convened a meeting of supervisors which the two banking groups operate. It also conducted assessment of the legal and regulatory frameworks and supervisory practices in the seven jurisdictions.

For the East African Community members, there was convergence. However, there is a need to continually monitor the other non-converging jurisdictions. Additionally, as the two banking groups expand beyond the EAC region, the CBK will have to expand its working arrangements with the host regulators, specifically focusing on host country assessments.

Finally, there is also the inability by the home regulators to administer fit-and-proper assessments on shareholders (and directors) at the holdco level, again due to lack of robust supervisory oversight of holding companies.

End

Leave a Reply

Your email address will not be published. Required fields are marked *